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A structured settlement is a series of payments made to a claimant, who wins or settles his or her lawsuit, over a fixed period. The claimant should consider his or her tax liability, how he or she plans to spend the settlement money, and whether he or she will require help in managing a huge sum of money before deciding whether to take the settlement as a structured payment or a one-time lump sum. This guide will discuss structured settlement options, factors to consider when choosing between a structured and a lump-sum payment, and advantages as well as disadvantages of a structured settlement.
Structured Settlement Options
If a claimant opts to receive his or her settlement as a structured payment rather than a one-time large amount from the defendant, the claimant will receive incremental amounts over a specific number of years. If the settlement amount is $480,000, for instance, the structured settlement agreement might demand the defendant to pay the claimant $60,000 every January for eight years. The following are common structured settlement options:
A Big Initial Payment
Assuming the claimant lost his or her source of income because of his or her disabling injuries and the bills are rising. The claimant can go for a structured settlement design that offers a big initial payment so that he or she can take care of outstanding bills, make mortgage payments, or buy must-have items like a wheelchair. The smaller series of payments that follow could then serve as a replacement for lost income.
Payments Rise Over Time
A claimant can design the structured settlement such that payments increase yearly. In this option, the payments will be low at the beginning and relatively higher towards the end. This option is perfect for claimants who expect their income to decrease over time.
Payments Drop Over Time
This structured settlement option involves the payments starting high and going down over the years. It’s the best option for claimants who expect an increase in their income over time.
Additional Amounts for Unusual Expenses
On top of yearly payments, this settlement option offers additional amounts to cover unusual expenses such as college tuition.
Claimants can also design their structured settlements to delay payments for several years or until they retire.
Choosing Between a Structured Settlement and a One-Time Lump Sum
A claimant should consider a few factors before deciding to choose either a structured settlement or a one-time lump sum payment. This is because the choice that he or she makes might have long-term tax and personal implications. The following are factors to consider.
The settlement amount can be either tax-free or taxable depending on whether it’s meant to compensate the claimant for injuries sustained, illness, or punitive damages (which means they are a punishment to the defendant for his or her actions). The payment arrangement, structured or lump-sum payments, can also have tax implications for the claimant. Claimants should familiarize themselves with state-specific laws and seek clarifications from a tax attorney if possible. They should specifically strive to understand the Periodic Payment Settlement Act of 1982.
Having the Capability to Manage a Huge Lump Sum Award
Most claimants can’t independently manage a huge lump sum award effectively. Instead, they turn to a financial advisor for guidance on the best way to spend and invest their money. A successful claimant is, therefore, likely to spend some of his or her settlement money to cater for this service, especially if he or she doesn’t have a competent relative or friend ready to advise him or her for free or at a lower cost. Some claimants opt for structured settlements to save themselves from costs and challenges that come with managing a huge amount of money.
How the Claimant Intends to Spend the Settlement Money
Perhaps the claimant needs the whole settlement amount at once to pay overdue bills or buy a new car. Maybe he or she wants to donate it all to charity. How the claimant plans to use the award will determine whether he or she will opt for a structured settlement or a lump sum payment.
Advantages of Structuring a Payment
Structured Settlements are Properly Managed
As previously mentioned, a structured settlement can work perfectly well for individuals who lack the expertise to manage a large amount of money. Opting for a structured settlement, however, doesn’t prevent the claimant from receiving a huge initial lump sum payment upfront. The claimant can design his or her structured settlement such that he or she will receive some of the settlement money as a lump sum and the rest as regular payments over the years.
Structured Settlements Lower Expectations of Relatives and Friends
People who have suddenly come into a huge sum of money are more likely to encounter friends, relatives, and even strangers looking for handouts. Receiving the award as regular payments can help successful claimants avoid this unexpected pressure.
Structured Settlements Money is Tax-Exempt
One of the biggest advantages of a structured settlement over a one-time large sum award is that the money the claimant receives is tax-free. Under the Periodic Payment Settlement Act of 1982, the earnings from a structured settlement are categorized as tax-exempt income.
Structured Settlements Can Be Customized to Suit the Claimant’s Needs
Through a structured settlement, a claimant can receive customized payments regularly in fixed intervals over the years. The claimant can, for instance, design his or her severe car accident injury settlement to meet his or her unique cash flow needs, such as medical and educational costs, large purchases, and daily living expenses.
Disadvantages of Structuring a Settlement
Limited Control Over the Settlement Money
Structured settlements offer successful claimants limited control over their money. Another party is responsible for managing and investing the money. The claimant takes a back seat when it comes to deciding where the money should be invested.
Risk of Losing a Huge Portion of the Settlement Money through Administrative Fees
Some states don’t require insurance providers to reveal their fees for setting up a structured settlement annuity. Without this crucial information, a claimant is highly likely to lose a substantial amount of the settlement money through administrative charges.